Great Expectations: Performance of survey inflation expectations at improving model-based inflation forecasts

This note explores which survey measures of inflation expectations improve the forecast performance of linear time series models for headline inflation in New Zealand over the period 1996-2021. We use inflation expectations from surveys of consumers, businesses and professional forecasters in a pseudo-out-of-sample forecasting exercise for headline inflation up to 12 quarters ahead. Incorporating survey-based inflation expectations data in linear models typically enhances the accuracy of headline inflation forecasts across different horizons. Among different survey measures, the mean of RBNZ 1-year household inflation expectations survey demonstrates the strongest predictive ability. For policy purposes, a range of measures of expectations are always taken into account, and many different measures contain useful information for policy. Key findings: - Inflation expectations are essential for effective monetary policy as expectations affect current pricing behaviour. - Our results indicate that forecasts for headline inflation that include inflation expectations are significantly better than similar forecasts without survey inflation expectations. - The 1-year mean RBNZ survey of household inflation expectations has the best predictive power for the headline inflation, although the difference is small relative to other survey measures.